America’s financial system is notoriously complex, largely in part due to the credit system. Lending organizations, including banks, utilize these three-digit scores as assessments of an individual’s creditworthiness. Typically, these scores are created by reviewing a person’s repayment history. Scores are also impacted by someone’s credit history and the number of open credit accounts they have.
Unfortunately, 76 million Americans are negatively impacted by having little to no credit history. 61 million have thin credit files, meaning they have less than four lines of credit open and 16 million have no credit history at all. Certain groups—young individuals, immigrants, widows, divorcees, and those who only make cash transactions—have a disproportionately higher likelihood of falling into this category.
A person with poor credit may experience a variety of negative effects, such as limited employment opportunities, unfavorable loan terms, restricted rental options, and exorbitant interest rates. Rising interest rates result in additional costs that are particularly harmful. For example, over the course of three months, over the course of a 30-year mortgage, homeowners may pay over $30,000 in additional interest, raising the average monthly payment to $1,775. A more comprehensive evaluation of credit scores is needed to create a more equitable system. Accepting alternative data when determining a person’s creditworthiness is a potential strategy already being used by different lending institutions. Alternative data is information that complies with the Fair Credit Reporting Act that is able to show a person’s capacity to repay loans over time, such as bill payment histories. By using this data, millions of people who were previously ineligible for credit could be granted access to it. In addition, it is possible for people with existing credit scores to notice an improvement in their current scores when alternative data is considered, by up to 25 points.
